28th August 2012
This and other questions are tackled by Psy-Fi blog's Tim Richards in his forthcoming book The Zeitgeist Investor: Historical Tales Of Behavioral Bias From The Psy-Fi Blog.
Evidence suggests that markets are primarily driven by the waves of emotions of a particular time alongside a wide range of behavioural biases, rather than rational self-interest:
'Hindsight bias, commitment bias and confirmation bias are permanent afflictions, we all suffer from them all the time….The zeitgeist of the market is nothing more than the total sum of human fears and aspirations'
Trapped in narrative sentiment
So while few of us can claim to successfully override current sentiment and make rational investment decisions, except perhaps the likes of Soros and Buffet, this book helps explain tips that might help.
Richards writes: "This is the opportunity for the Zeitgeist Investor, if they can figure out where they are in the cycle of the markets and can learn to control their over-confident, over-active brains."
To truly understand the markets, an investor needs knowledge of how to value a company, an insight into their own psychological make-up, and an understanding of the history of previous market twists and turns.
Markets turn along with sentiment, and their behaviour is short-term. So when there is a period of positive sentiment more of us are likely to plough capital into markets, feeling confident of a positive return. Alternatively, when the cloud of depression hits during recession we'll either sit and wait – and do nothing – or panic and pull out of the market at precisely the wrong time.
Yet Richards writes: "Changing times require us to adapt our approach to investing, but however and whenever we do this we're not going to succeed by simply drawing on our own observations of the tiny subset of the world we have a personal window on.
"Good investors read widely, think deeply, trade rarely and retain an emotional distance from their investments. Unsurprisingly they're hard to find."
So how do we cope with the highs and lows of stock market investing?
Edward Hocknell, former partner of asset manager Baillie Gifford, and a Mindful Money blogger, says: "If we want a reasonable prospect of real long-term returns, we usually have to invest in equities- and that means having to cope with uncertainty. Indeed, the great economist John Maynard Keynes suggested in the 1930s that the holder of quoted equities requires "much more nerve, patience and fortitude than… the holder of wealth in other forms".
He agrees with the notion of a moment in time often having too great an influence, writing: "It seems to me that the greatest enemy of successful investment is ‘events'. We are all participants in an endless parade of happenings, which, being human, we continuously try to integrate into our world view."
Such is the basis of narrative therapy, which holds that our identities are shaped by the accounts of our lives found in our stories or narratives. A narrative therapist is interested in helping others fully describe their stories to distance themselves – so become your own narrative therapist, and this might help your investment skill.
Hocknell points to Daniel Kahneman's book Thinking, Fast and Slow, showing how we instinctively default to the most recent or striking piece of evidence, and that our urge to leap to conclusions overwhelms our better, rational selves.
Keeping a cool head
Richards' book guides investors through history and behavioural biases so that they can be aware and prepared for the next shift in the zeitgeist. What do you think this will be, and how should it be managed?
In the meantime, if you feel the weight of current sentiment and events pressing hard, focus on keeping cool:
When the zeitgeist is entirely driven by emotion, and there's no one who's rational and adult to be seen, then the only sensible reaction is to withdraw to the high ground, get comfortable, and wait.
Develop awareness and self control, and you'll be on the right investment path.
More on Mindful Money:
To receive our free daily newsletter sign up here.